Futures Slide As Ukraine Fighting "Re-Escalates" Again

If you like your de-escalation, you can keep your de-escalation. To think that heading into, and following the Russia-Ukraine "summit" earlier this week there was so much hope that the tense Ukraine civil war "situation" would somehow fix itself. Oh how wrong that thinking was considering overnight, following rebel separatists gains in the southeast of Ukraine which included the strategic port of Novoazvosk [33]and which is "threatening to open up a new front in the war [34]" including setting up a land corridor to Russia controlled-Crimea, Ukraine's president Poroshenko for the first time came out and directly accused Russia of an "Invasion", or at least a first time in recent weeks, saying he has convened the security council on the recent Russian actions.

And while none of this is particularly new or unexpected, that it happens on a day in which Europe reported yet another batch of very adverse data, including a big drop in European confidence as well as Spain sliding again into outright deflation, is hardly supportive of risk especially following yesterday's Reuters comment that no ECB action is to be expected absent a dramatic slide in inflation. As a result bond yields have fallen to fresh record lows across the board, pushing US TSYs higher as well, while for the first time equities can't find solace in the hope that bad news out of Europe is really great news out of the ECB, and as a result have tumbled.

In the Asian session overnight, major bourses are mostly trading softer following the lackluster performance in US and European equities yesterday. The Nikkei and the Shanghai Composite are down -0.5% and -0.6%, respectively. Away from equities, Treasuries have firmed further following on from yesterday’s rally. As we go to print the 10yr and 30yr UST yield is around 2.35% and 3.10%, respectively. Indeed following the 4bp and 6bp decline in the 10yr and 30yr UST yield yesterday, the 10s30s curve is now around 75bps and the flattest as it has ever been since 30 Sept 2009. The 10s/30s was nearly as wide as 100bps in February but in reality it has been on a flattening trend throughout the course of this year. The flatter US rates curve is also providing support to longer dated USD sovereigns in Asia.* Asian stocks fall with the Sensex outperforming and the Hang Seng underperforming. MSCI Asia Pacific down 0.3% to 148.3, Nikkei 225 down 0.5%, Hang Seng down 0.7%, Kospi up 0%, Shanghai Composite down 0.6%, ASX down 0.5%, Sensex up 0.3%. 2 out of 10 sectors rise with telcos, health care outperforming and energy, utilities underperforming

European shares fall with the basic resources and financial services sectors underperforming and utilities, food & beverage outperforming. The Swedish and Italian markets are the worst-performing larger bourses, the Dutch the best. Spanish 2Q GDP in line with estimates. Italy’s top banks said to seek up to $36b from ECB. The euro is stronger against the dollar. Greek 10yr bond yields rise; Portuguese yields increase. 1 out of 19 Stoxx 600 sectors rise; utilities, food & beverage outperform, basic resources, financial services underperform; 20.2% of Stoxx 600 members gain, 77% decline.

Looking to the day ahead we have quite a busy day for data. In Europe we have Spanish August inflation data (expected -0.6% MoM) and the second read on Spanish Q2 GDP (expected unch at +0.6%), German August unemployment and inflation reads (expected at 6.7% and +0.0% MoM respectively), Italian June retail sales and business confidence (expected at -0.5% MoM and 99.2 respectively) and also Euro area August economic, industrial, consumer and services confidence which are expected to come in at 101.5, -4.5, -10 and 3.5 respectively). Over in the US we have August initial jobless claims (expected in at 300k), the second read on Q2 GDP (BBG consensus is for a read of +3.9% whilst DB expects it at +3.8%) and the second read on Q2 Core PCE (BBG consensus is for a read of +2%), July Pending Home Sales (expected +0.5% by the market and +1.5% by DB) and the Kansas City Fed manufacturing index (expected in at 7).

Market Wrap

S&P 500 futures down 0.4% to 1989.5
US 10Yr yield down 3bps to 2.327%
German 10Yr yield down to at 0.88%
MSCI Asia Pacific down 0.3% to 148.3
Gold spot up 0.5% to $1289.3/oz

Bulletin Headline Summary from RanSquawk and Bloomberg

European fixed income markets retreat from all-time highs as German and Spanish inflation data dampen the case for ECB action next Thursday
European equities slump on further evidence of Russian activity in eastern Ukraine and dwindling prospects of ECB action
Attention turns to US GDP (expected to be revised to 3.9% from 4.0%) and the final issue from the US Treasury (USD 29bln 7yr Notes)
Treasuries gain, 10Y notes near 2.339% support as ECB rally continues; 10Y bunds yield 0.89% as Ukraine warns of Russian invasion, Germany threatened Moscow with further sanctions.
Week’s auctions conclude with $29b 7Y notes, WI yield 2.032% vs 2.250% award in July
Pro-Russian rebels widened their attacks on government forces, taking several towns outside the strongholds of Donetsk and Luhansk, including near the Sea of Azov, opening a new front and supply channel, according to a Ukrainian official
Euro-area economic confidence fell more than forecast, Spanish consumer prices dropped the most in five years and German unemployment unexpectedly rose in a burst of data backing Draghi’s warning that more stimulus may be needed
Rising stress in China’s $6t shadow banking industry is testing central bank Governor Zhou Xiaochuan’s resolve to limit monetary easing as risks to the government’s growth target climb
Emmanuel Macron’s appointment as France’s economy and industry minister in place of Arnaud Montebourg shows the gulf between rank-and-file members of Hollande’s Socialist Party and the competing visions of France’s economic future
A year after he threatened attacks on Syrian forces loyal to President Bashar al-Assad, Obama is weighing airstrikes against Islamic State extremists in Syria that could benefit Assad
More than 20,000 people may be infected with the Ebola virus before the outbreak in West Africa is controlled, the World Health Organization said as it sought $490m in funding
The IMF’s board will meet as early as this week to hear Managing Director Christine Lagarde explain her involvement in a French court decision that threatens to tarnish the lender’s reputation
Sovereign yields extend declines. Asian, European stocks, U.S. stock futures decline. WTI crude and copper lower, gold gains

US Econ Docket

8:30am: GDP Annualized, 2Q revised, est. 3.9% (prior 4%);
Personal Consumption, 2Q revised, 2.4% (prior 2.5%)
GDP Price Index, 2Q revised, est. 2Q revised, est. 2% (prior 2%)
Core PCE, 2Q, est. 2% (prior 2%)
8:30am: Initial Jobless Claims, Aug. 23, est. 300k (prior 298k)
Continuing Claims, Aug. 16, est. 2.51m (prior 2.5m)
9:45am: Bloomberg Consumer Comfort, Aug. 24 (prior 36.6)
10:00am: Pending Home Sales m/m, July, est. 0.5% (prior -1.1%); Pending Home Sales y/y, July, prior -4% (prior -4.5%)
11:00am: Kansas City Fed Manufacturing Activity, Aug., est. 7 (prior 9)
1:00pm: U.S. to sell $29b 7Y notes

FIXED INCOME

Bund futures softened from the open as markets pulled back their expectations of ECB easing as soon as next Thursday. Spanish and German CPI data continued to show a dire inflation picture across the Eurozone, however failed to provide what ECB sources referred to as an ‘inflation slump’ yesterday, in order to drive the ECB toward ABS purchases. Furthermore, ECB money supply data ticked higher than expected (1.5% vs. Exp. 1.3%), supporting the view that June’s easing measures could be sufficient to drive inflation expectations higher. As such, Eurozone spreads modestly widened against the German benchmark, with Italian underperforming as EUR 6.5bln of BTP issuance came onto the market at an unsurprisingly record low of 2.39% on 10yr debt.
Final Barclays month end extension for Pan-Euro Agg at +0.03y (Prev. 0.12yrs, 12m average +0.03yrs), Sterling Agg Tsy at +0.08y, US Treasuries +0.13yrs (Prelim. +0.12yrs, 12m average +0.09yrs)

EQUITIES

European equity markets trade softer, with underperformance in the benchmark DAX as dwindling expectations of ECB ABS purchases, or ‘private QE’, alongside further militarization in eastern Ukraine drags equities away from multi-month highs printed earlier in the week. The leader of the pro-Russian separatists Zakharchenko stated that serving Russian soldiers are among the rebel ranks, however are operating on leave from their posts in order to fight with the separatist military – further heightening concerns that Russia could fall under further sanctions pressure. Separately, UK miners sharply underperform, with Rio Tinto and Anglo-American falling as much as 2.5% after Chinese iron ore futures slumped as much as 3% to contract lows overnight as a clampdown on credit weighed on industrial metal purchases. US stock futures have been dragged down by their European counterparts, indicating a lower open on Wall Street.

EUR/USD reclaimed 1.32 on the back of stronger than expected ECB money supply figures, and continues to trade in between large expiring option strikes at 1.3200 (USD 1.14bln) and 1.3250 (USD 2bln), due to roll off at the 1500BST NY cut. Elsewhere, AUD/USD broke above the 50DMA after Q2 Australian Private Capital Expenditure posted the first positive reading since September 2013 (1.1% vs. Exp. -0.9% (Prev. -4.2%, Rev. -2.5%), a result likely to be welcomed by the RBA ahead of their rate decision next week, especially given the recent poor data out of Australia.

COMMODITIES

Spot gold and silver have been supported from the open by the weaker USD and the tensions in eastern Ukraine. Silver sharply outperforms, lifting spot gold toward the 100DMA at USD 1,295.50. WTI and Brent crude futures trade lower after yesterday’s build in Cushing OK stockpiles, further pressured by expectations of Libyan production coming back online (expected to reach 1mln bpd by the end of September).

* * *

DB's Jim Reid concludes the overnight recap

Yesterday European government bond yields once again hit new all-time lows as the 10 year yields on Dutch, German, Spanish, Italian and French government bonds all shed around 2-4bps. The 10Y Bund has been trading sub-1% in yield since August 21st and reached an intraday low of 0.895% yesterday before closing at 0.91%. This all comes on the back of what has been a truly impressive month for the asset class which has seen 10 year government yields across Europe drop, including on Dutch (-28bps), German (-22bps), Spanish (-41bps), Italian (-37bps) and French (-26bps) govies. These moves have come on the back of a darkening picture for the euro area economy and a rise in the probabilities being attached to ECB QE (more on this later) but have also been part of a broader global downward trend in yields. UK and US 10Y government bond yields have also dropped 18bps and 12bps respectively this month. We have talked previously about the ongoing debate as to the destination of long-term bond yields in this cycle and in an interesting recent paper entitled, “The Revived Bretton Woods System’s First Decade” DB Group Chief Economist David Folkerts-Landau adds to this debate whilst discussing the current global macroeconomic system and the role China has played in it over the past decade. On the real rates issue the piece highlights how, “China’s … export-driven development strategy has depressed long-term real interest rates in industrial countries at every stage of the business cycle. This occurred because exchange rate undervaluation generated massive exports of capital via official intervention, absorbed principally by the US. Even as the China phase of the system gradually ends, long-term real rates are likely to stay unusually low because there is still a large pool of surplus labor for the global system to absorb.”

Moving back to yesterday’s moves, one of the big pieces of news was that the ECB has hired BlackRock to advise it on developing a program to buy asset-backed securities (Bloomberg News). Our main take-away from this news is that it is further evidence (if more were required) that the ECB is very much walking down the path to QE. As we noted in yesterday’s EMR, our European economists expect the ECB to announce private QE at their next meeting on September 4th. Yesterday’s weak confidence data probably increased the pressure on the ECB to act as French August business confidence fell to 91 (vs expectation it would hold at 93) and manufacturing confidence fell to 96 (from 97), the Italian August consumer confidence index read came in at 101.9 (vs 104.6 previously and 104 expected) and German September consumer confidence fell to 8.6 (from 9 previously and 8.9 expected). French July jobseekers data also disappointed, rising +26.1k vs expectation it would rise +14.5k. On the back of this data equity markets seemed in wait and see mode yesterday and were broadly flat in Europe and the US. European credit underperformed with iBoxx Main widening +0.5bps and Xover +3bps wider.

Turning to the Asian session overnight, major bourses are mostly trading softer following the lackluster performance in US and European equities yesterday. The Nikkei and the Shanghai Composite are down -0.5% and -0.3%, respectively. Although the Hang Seng (+0.2%) and KOSPI (+0.2%) are somewhat more resilient this morning. Away from equities, Treasuries have firmed further following on from yesterday’s rally. As we go to print the 10yr and 30yr UST yield is around 2.35% and 3.10%, respectively. Indeed following the 4bp and 6bp decline in the 10yr and 30yr UST yield yesterday, the 10s30s curve is now around 75bps and the flattest as it has ever been since 30 Sept 2009. The 10s/30s was nearly as wide as 100bps in February but in reality it has been on a flattening trend throughout the course of this year. The flatter US rates curve is also providing support to longer dated USD sovereigns in Asia.

Before we wrap up with the day ahead, there are fresh reports that Russian troops have launched an incursion into south-east of Ukraine (BBC). Ukraine said Russian forces had crossed the border and were supporting separatist attacks and the US State Department said it suspected a Russian directed counter-attack was underway. German Chancellor Merkel has demanded an explanation from Mr Putin. A rebel leader in Donetsk told reporters that Russia was not involved in the current offensive. Clearly this remains an ongoing story but geopolitics seems to have taken a backseat for now given the focus on ECB's upcoming policy moves.